Fed Balance Sheet, Illustrated Edition

A while back, James Hamilton had a couple of posts on the recent explosion of changes to the Fed’s balance sheet. Being curious how the Fed’s balance sheet might have changed (if at all) in the couple months since, I decided to gin up my own set of pretty graphs, using the same H.4.1 Releases that Dr. Hamilton used. Herewith, the results of my labors:

Although it’s tempting to view the expansion illustrated above as simply the Fed running the printing press, it’s not clear to me that this is in fact the case. The Fed views its current policies as being, in the main, variants on its traditional functions of 1) lender of last resort, & 2) stimulating the economy via lower interest rates. See, e.g., this recent article by the Dallas Fed. In this view, the Fed’s expanded balance sheet is one aspect of a de facto policy of regulatory forbearance, aimed at not only avoiding an even more serious economic downturn, but also keeping the banking system on life support ’till it’s able to earn its way back to health. Other aspects of this policy include FDIC guarantees for bank bonds, and (of course) TARP.

Although, IMHO, forbearance is less preferable than other courses of action, it is a potentially workable solution. It does depend, crucially, on the maintenance of strong loan underwriting by banks. In this regard, the recent tightening of lending standards by banks is actually an encouraging sign, since it suggests that they may not end up abusing forbearance the way the S&Ls did back in the ’80s. OTOH, forbearance inherently grants government leverage over banks. My concern is that the government might abuse such leverage to politicize credit allocation. IMHO, the mandatory participation of TARP institutions in the Obama housing bailout is one example of this. The recentexperience of TARP banks in the Chrysler bankruptcy is another.

I’d like to think these incidents will be exceptions to the rule. But I’m not sanguine.